July 09, 2009

Do You Need $1,000,000 Set Aside to Safely Retire?

For years, the financial planning community recommended that you focus on having $1,000,000 saved by the time you retire.That has always been a general target figure, of course, as the needs of people vary widely, but it has long served the purpose as a standardized number that’s neither insufficiently low nor needlessly high.The historical idea has been that if you had $1,000,000, that principal sum would be enough to generate about $40,000 per year (assume 4% in annual interest) reliably in interest income, which, combined with another $20,000 per year in Social Security, would give you about $60,000 in income; your principal of $1,000,000 wouldn’t be touched with any regularity, but would be available to access if things got surprisingly bad, and would also be enough to cover end-term medical expenses and other final costs.The important companion assumption that has been made on behalf of the idea that $1,000,000 is enough is that you’ve also paid off your mortgage and other consumer credit accounts by the time you retire.

I think the answer is that most people can retire on a savings of $1,000,000, but perhaps the more important issue is having the ability to generate $60,000 per year for yourself over the course of your retirement years.Looking at the question that way relieves you, perhaps, of having to fixate on saving $1,000,000. For example, if you continue working in a low-impact sort of way (from home, part-time, etc.) and can earn $20,000 per year like that, and can rely on another $20,000 in Social Security (I know what you’re thinking, but we have to make some assumptions here), your $1,000,000 savings requirement now drops to $500,000 (4% of $500,000 gives you $20,000 per year in interest income).$500,000 in savings may still be a tall order, but it’s obviously more reachable than $1,000,000.

These days, when securities and real estate markets are performing in most uncertain fashions, we have to be creative when analyzing potential sources of retirement income. The key to a successful retirement may lie less in actually having the requisite savings capitalization to generate all or most of your income, and more in determining your income requirement early on and then considering all the available means by which you can achieve it.